Can the Financial Industry Make Us Climate-Resilient?

That the world is warming is increasingly undeniable, and by all observations and credible scientific projections, the consequences of this warming will grow more far-reaching and disruptive to our society and economy.

Impacts from the changing climate are already manifesting in human and financial losses around the globe. The almost total destruction of the island of Abaco in the Bahamas by Hurricane Dorian underscores the urgent imperative to adapt to climate change by making neighborhoods, businesses, and infrastructure more resilient. This is true not only for places facing super-charged hurricanes, but it is also true for those in floodplains which have experienced numerous 1-in-500-year rain events in the span of a few short years.

Even the world's wealth and power centers are vulnerable. Look no further than Manhattan, where business and political leaders gathered in September for the United Nations General Assembly and Climate Week NYC. Almost seven years after Hurricane Sandy, much of New York City still confronts acute risk of storm-surge flooding as well as urban heat island effects, increased ground-level ozone, and other climate-related threats.

Vast Potential

In the face of dire warnings and fearsome extreme events, the push to invest in climate solutions may sound to many in the private sector like a plea for charity or a call for regulation. But the financial sector must recognize that investing in adaptation now is imperative from the perspective of risk management, but it is also perhaps the biggest investment opportunity of this generation.

As we highlighted in our July 2019 report, Driving Finance Today for the Climate Resilient Society of Tomorrow, commissioned by the Global Commission on Adaptation (GCA) to inform its 2019 flagship report, the financial system is woefully unprepared for climate change. Our report unpacks why, and it highlights how grappling with the implications of climate change will both minimize potential costs and create enormous opportunities for profitable investment by all types of investors.

The recently released GCA report, Adapt Now: A Global Call for Leadership on Climate Resilience, notes that investing $1.8 trillion globally from 2020 to 2030 in adaptation projects could generate as much as $7.1 trillion in net benefits. These adaptation investments include projects such as implementing drought-tolerant agriculture, expanding access to climate-informed digital advisory services, and increasing flood protections in major cities.

Investors, asset managers, and lenders are slowly waking up to just how profoundly climate change will alter traditional assumptions about risk and return.

Need to Step Up

One of the central recommendations of our paper is that financial institutions need to dramatically step up climate risk management practices, including the assessment, quantification, and management of climate-related financial risks in their investments, whether they are investing in real estate, water treatment plants, or transportation. In so doing, investment opportunities are also emerging. For example, the threat of increased water stress bolsters the prospects and financial returns of advanced water treatment and drip irrigation technologies as well as drought-resistant crop varieties.

The issue of climate preparedness was central to the General Assembly and Climate Week agenda. In fact, addressing climate risk has become so fundamental to financial stability that the incoming chair of the European Central Bank, Christine Lagarde, recently underscored climate change as not only a pressing global challenge, but also critical to the ECB's mission. Further, the Bank of England, Financial Stability Board and European Union have led the charge to address climate risk as a matter of financial oversight (with the United States conspicuous in its neglect of the issue).

These efforts have focused on the development of practical policy approaches that support better risk management of climate-related issues through guidelines, metrics and, in some cases, stress testing and disclosure requirements.

Engines for Adaptation

But central banks and financial regulators can't solve this alone, nor should they. It is in the self-interest of the financial industry to address new risks brought about by climate change and to scale up the necessary investments to make our societies more resilient. Both will require good financial policies that take into account the goal of societal resilience and economic growth as well as the proactive engagement of the financial community to tackle the risks and opportunities.

The good news is that managing risks is already in the core DNA of all financial actors, whether they seek high returns, stable growth, or preservation of capital. Once they integrate climate change into their risk-return analyses, they'll not only build more climate-resilient portfolios, but also become the engines for climate change adaptation that scientists and policymakers have long been calling for.

[NOTE: The July 2019 report Driving Finance Today for the Climate Resilient Society of Tomorrow was originally generated by Climate Finance Advisors for the United Nations Environment Program - Finance Initiative (UNEP FI) and used as a background report for the full Global Commission on Adaptation report.]

Stacy Swann (sswann@climate-fa.com) is CEO of Climate Finance Advisors, a boutique consulting firm working to accelerate sustainable, climate-smart investments and to integrate climate considerations into financial products, services, and policies. She has more than two decades of experience in finance, fund management, and development. With the International Finance Corp. she was head of the Blended Finance Unit and was responsible for managing and investing more than $750 million in donor funding for climate-smart investments. Alan Miller is a senior advisor at Climate Finance Advisors who retired from the IFC in 2014. His work for clients includes a UNDP project supporting modernization of weather observation systems in 11 African LDCs; a U.S. AID program on the economics of climate change; and helping produce a World Bank publication on energy access.